Last month we stated here that the underlying valuations of stocks don't support the current pricing in stocks as a whole. Stocks continue to be overpriced! This is true for analysts of different outlooks, those who do fundamental and technical analysis both. It's obvious to us that this is still true today and yet markets continue marching higher overall. So, for many clients, we straddle the risk fence and are constantly watching our quantitative risk parameters.
The real underlying and largely ignored issue is, by and large, no one on a broad scale is valuing risk so it enters the equation faster and it is still being pushed aside by many investors. Thankfully the government bond market sees all this risk and is trying to get priced (upward) appropriately (bonds can tend to smell fear and bonds never lie).
1) Still stocks continue diverging from traditionally accepted price supports as prices move up and profits are fully flat. Profits are flat to negative year over year and prices were trudging higher and higher. Stock prices are up more than 20% during Feb 1, 2019 to Feb 1, 2020 but profits have not risen at all to support this rise in price. With 231 of the S&P 500 companies reporting for the 4Q of 2019, profits are -.23. What could go wrong?
2) The average investor is divergent in their historical approach to accepting (really somewhat ignoring) more risk than they have during the past decade. (Remember what happened just over a decade ago-it set the markets back eleven (11+) years). (#2 here is fully related to #1)
As of late.
January was all about showing some steady strength, almost day after day and then, someone mentioned a virus. While this has so far not turned out to be what some initially feared to be as a pandemic, it began to take it's market toll. Began. As of today, over a 1000 people have lost their lives to this deadly disease. However though some of the initial fears of a pandemic have seemingly been kept at bay. Cooler heads have prevailed on this issue to date.
January 2020 showing the S&P 500
This is the type of thing that markets do not like. Surprises. Especially negative ones. People will often ask me questions like, "What will the markets do if ______________ happens? The reality is that no one knows with 100% certainty what markets will do. The market response is typically not grounded in what does happen in the world but it is often juxtaposed against what the markets think will happen versus what actually does happen. This is where the grind is.
So, this is why we see the dip at the end of January, the surprise and all the potential unknowns about this virus. As mentioned above, markets do not like surprises. Some are even asking if this could be another fabled "Black Swan" event. From a medical laymen's standpoint, it seems that it's just too early to tell specifically and more data with increasing details is coming on almost by the hour. Markets could never see something like this coming along so this surprise can possibly shutter the thoughts of even the most ardent optimist.
Over the years, I have been quick to remind people that markets always loose money faster than they make it. Always. While I am not attempting ring the alarms bells on or about this virus issue, I will say that this could develop into the type of issue which could be a triggering event in which we possibly see a larger downturn. Since we are constantly looking at risk factors we watch them to tell us or help us read risk as we attempt to measure items we believe can weigh to heavily against markets. When we see these things in motion, this is what allows us to step in and act to avoid taking on too much risk for the given appetite for each client which we evaluate when they first come on board.
A LONGER TERM VIEW - IN THE REAR VIEW MIRROR
In this section I always enjoy putting the long term in view and recalling the facts about the long run. It seems when markets are good/strong in the current environment, the long term is never really as good as people typically think it was and then conversely, in heavily declining markets, things are never as bad as people typically recall them being. It is as if our own brains enjoy us playing tricks on ourselves. This is why daily watching of data is so critical.
So, with 2019 being a year for the S&P 500 with a much bigger upside than anyone suspected, it is interesting as I talk with people how many think that the markets are up huge for the last couple of years. When I ask people to define "huge" I am often hearing, "big double digits" or "I dunno, more than 20% per year" or "the best market we have seen in decades". Oddly, the facts are somewhat different from those notions.
For the last two years, January of 2018 to January 2020, the real rate of return for the S&P 500 is actually 6.7% or 8.4% if you include dividends. Most of the conversations I have, client or professional both, don't realize the number is this soft/low.
The same is really even more true when we look at the last twenty years. If you look closely at the graph below, stocks and U.S Government bonds are both up more than 140% over the last twenty years. 140% might seem like a huge number but when it is compounded over 20 years, it actually turns out to be a relatively low number. The real rate of return for stocks is just over 4% per year and if we add dividends in, it is just over 6%. An important note to make here is starting with the value as of January 2000, the S&P 500 was essentially delivering negative returns for that full 12 year run. Not exactly an overwhelming and compelling investment history.
The S&P 500 compared to the Long Term U.S. Government Bonds since January 2000
The bigger point shown above is the fact of long term U.S. Government Bonds, which are backed by the full faith and credit of the U.S. Government, yielded the same rates of return overall as did the S&P 500 during this 20 year cycle. The difference, bonds were not delivering negative returns during the initial 12 years of this century as the S&P 500 delivered.
As stated in a previous newsletter recently, we want to be clear here that it is not the position of CRA to advocate using an all U.S Government Bond portfolio for clients on a broad basis. But, since stocks tend to get all the limelight day in and day out, bonds do deserve some respect and the facts do speak for themselves on bonds as well as stocks.
Will the driving of recency bias continue?
The recency bias which we have discussed here as of late may be beginning to fold. It fell in December but reversed in January and rose. Things out of the blue like the announcement of the coronavirus can shake consumers greatly and quickly. Just as I stated that markets go down much faster than they go up, this is even more true with consumer confidence which is by far the biggest driver of recency bias. Confidence tends to begets confidence but it also can come at the wrong time, when there is little to support the confidence or back it up. As we stated last month consumers seem to be confident, too much so in our view, but again this confidence can be quite fickle and vanish in a moment. December consumer confidence did slip back just a bit. We also continue to watch the delinquency rates on various loans rising. A very interesting note about loans, credit card lending delinquencies are about the same as mortgage lending delinquencies. Both are in the 2.5% range and moving upward, definitely the wrong direction.
We remain watchful.
Ken Graves, Chief Investment Officer
Capital Research Advisors, LLC
Capital Research Advisors, LLC,
4185 B Silver Peak Parkway,
Suwanee, GA 30024
800 -767- 5364
All rights reserved
Mortgages- Just look at these Rates!
Mortgage rates are now on the move LOWER. They are down over 1/2 of 1% in the last 12 months! This is a change from the last 2-3 months. They are on the low end of their range and moving lower again. So our view is that there is more downward shift in rates to come. The economy in the U.S. is still about the best thing going as compared to the rest of the world but rising rates for mortgages would really begin to derail home construction numbers. As we said before, "Due to this, rates are short term likely to stay in this range with a greater possibility of moving lower rather than higher." This is EXACTLY what has happened! STAGFLATION may already be on the delivery truck for the global economy and that could push rates for mortgages lower from this range.
JOBS, INFLATION & MORE
Last month we reviewed the jobs issue and noted fewer jobs were actually created. Most cut backs are not in huge numbers at this point in time but with ISM (Manufacturing) slipping month over month and being lower than it has been in 128 months, more layoffs are likely soon to follow.
U.S. job availability is dropping month over month. We are now at our lowest in two years. Hiring has increased a bit but job growth will not likely be continuing higher though many would like for it to be. The Labor Department recently shows us an increase in layoffs. Job openings remain elevated, many economists are forecasting large declines since the end of 2019 and this can be a foretelling of the possible end to this very long economic expansion, 11 years currently!
Fed Chair J Powell has provided some encouragements about the economy and labor both but many are suspect of it being more hype than hope. He did state to the U.S. House that the economy was "in a very good place and performing well."
Job openings which really shows us the demands for labor, have slowed to its lowest number since December 2017. We are currently down more than 350,000 job openings at this point and it now stands at 6.4 million total openings and rising! Late in 2019 this number dropped by more than 500,000 in a single month (November), the largest drop since August 2015!
Job vacancies have dropped from their peak of 7.6 million and last month dropped by more than 15%. Some feel that the drop in job vacancies are more as a result of better job matching with new hires which results in less longer term turnover. In a one-on-one conversation with the founder of the Ritz-Carlton brand he stated that job matching was the key to the Ritz customer experience. He relayed to me that when you hire the right person and put them in the right job, the customer will win. You don't pay them more, you hire them better! To do this at Ritz, no matter what job you were being hired for, you HAD to interview with a minimum of four different staff members. This was whether you were going to be a part-time maintenance person OR the general manager. Now he says, at their new brand name properties, you interview with five different staff members. It always results in a better hire because the employer is more committed from the start and sees staff as assets rather than liabilities! Also, management seems to be even more committed to better training getting coupled with that new hire.
We attempted to create a better hire here at CRA in a recent hire we brought on. We simply added one extra person to the identifying and hiring process and to date, it seems to be completely spot on, amazingly so!
Any drop in job openings has really happened in the private sector markets for the largest segment. A few job openings occurred in transportation, retail, leasing and full time real estate. The education slice of the U.S. job market also saw a small amount of jobs go away without rehiring to fill those slots.
Experience has taught me choosing the right people to have in your life should be a well thought out, deliberate process.”
― Carlos Wallace